Best tax advice: Know limitations

Recently I was asked by a judge to describe Texas law on a key issue. I responded honestly -- I am only a federal tax lawyer and not qualified to address state legal issues. I know my limitations.

Recently a husband and wife came into my office to get help with unpaid taxes. It seems their employer had failed to pay its payroll taxes and the IRS had transferred those taxes to him. The wife spoke at length, explaining that her husband was not liable. I asked her what the federal law was governing responsible parties who acted willfully. She said she had no idea. I explained it was the tax law the IRS had used against her husband. She had no idea of her limitations in understanding federal tax law.

So today, I want to address two misconceptions regarding your federal tax returns that can cause a great deal of hardship if mishandled.

Unfiled tax returns: Many people fail to file their tax returns, often because they don't have the money to pay. They fool themselves into believing they'll file later on when they have the money to pay. In the meantime, they live in fear -- the stress often causing marriage and parenting problems. Some are so upset they just stop filing, hoping they won't get caught.

Here's the truth: The IRS has a sophisticated computer system that can match what you were paid by someone else (Forms W-2, 1099, CTR, etc.) with your personal tax return. If you don't file, it can catch you and notify a field agent. Even worse, the IRS computer can actually prepare and file a return for you -- often with no deductions, incorrect exemptions and wrong tax table rates. You may end up with a federal tax liability far in excess of what you might have owed had you filed. The IRS computer will also automatically impose every possible penalty and add interest, not just on the tax but on the penalties, too. This can be quite harsh.

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But it doesn't stop there. The IRS can look back and see if you failed to file returns in prior years, and if not, may do so for you. If there are no payor statements (W-2, 1099, etc.) an IRS agent can estimate an "average" tax liability or even audit your bank accounts and estimate your tax liability (e.g. all deposits are taxable income unless you can prove otherwise). And perhaps the worst part of this is it never goes away -- the three-year statute of limitations on assessment of taxes doesn't start until you file. That means the IRS can go back very many years.

Unpaid taxes: Never in the past 35 years have there been so many ways to handle unpaid taxes. The alternatives are complex, lengthy and often conflictive. But they are statutory -- which means the IRS must consider them and if it acts unreasonably, the courts can order the IRS to comply. A recent tax court case reflects just how bad the IRS can act and just how strongly the courts can respond.

The truth is that if you have failed to file returns, the IRS will likely catch you. This failure to file can be a crime. But if you act before the IRS contacts you, you may have choices for resolution. With the recent changes in federal tax law, there are lots of payment solutions. But most of all, don't hurt yourself by relying on your own advice -- know your limitations.

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